When it comes to selling a business, figuring out what it might be worth is most certainly one of the most important factors. The value of a business is determined by a lot of different factors, including its income, profits, assets, liabilities, risk factors and barriers to entry (to name a few).
Today, we are going to discuss some of the common methods for valuing a business, so you know you’re not either overdoing the price or underselling yourself.
Earnings Multiplier Method
One of the most common methods used to calculate the value of a business is the earnings multiplier method. This method involves multiplying the business’s annual profits (usually a weighted three-year average) by a multiple to determine the value of the business.
What is the multiple (I hear you ask)… well that depends on many factors. The biggest factor is the size of the business, and it is primarily an owner-operator style business, or management ran.
Owner-Operator Businesses
Smaller businesses tend to be led by owner-operators, and as such, we tend to use a multiple of the Seller’s Discretionary Earnings (SDE), which typically ranges between 1X to 2.5X the SDE.
Management-led Businesses
Businesses that fall outside of this remit use EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation), which is typically adjusted to factor in industry-average earnings for senior managers and owners. The vast majority of small businesses use a multiple between 3X – 5X EBITDA.
The multiple used is typically determined by the industry, competition, the business’s financial stability and a range of other factors.
Net Asset Value Method
This method involves calculating the value of a business by subtracting its liabilities from its assets. This will give you the net asset value of the business, which is a good indicator of its worth. Keep in mind that this method does not take into account the earning potential of the business, only its tangible assets.
Comparable Sales Method
This method involves looking at the sale prices of similar businesses in the same industry, location and similar size. This will give you an idea of what other businesses like yours have sold for and can be used as a benchmark to determine the value of your business.
Naturally, we strongly recommend hiring a business valuation expert. They can be a great way to determine the value of your business, and take the guesswork away. They will use a combination of the above methods, along with their experience and knowledge to provide you with a fair market value.
